IRS Cracking Down on 'Independent Contractors'

By Betty Wang, JD on July 31, 2013 8:13 AM

According to a recent Treasury Department report, the IRS is cracking down on the misclassification of "independent contractors." The consequences could be costly for business owners who aren't too careful.

For employers, the advantages of classifying a worker as an "independent contractor" are clear: You don't have to withhold income tax and you don't have to offer them any benefits, just to name a few.

But the Treasury report estimates that "millions" of workers are misclassified as independent contractors, when they really should be considered employees. How can you tell the difference, and what's the big deal, anyway?

Cost of Misclassification

According to the report by the Treasury Department's Inspector General for Tax Administration, the misclassification of independent contractors means businesses are failing to pay as much as $1.2 million in federal taxes each year, The Hill reports. That works out to about $3,710 in employment taxes per misclassified worker.

For employers who are caught misclassifying workers, consequences can include hefty fines, not to mention being forced to pay back taxes to make up for years of misclassification.

Behavioral factors. This is one of the most important distinctions: Who has ultimate control over the worker? With an independent contractor, the employer or company he works for is considered his client. That means the independent contractor gets to control his own hours and certain terms of his work that an employee may not have control over.

Financial factors. Think of expenses: An independent contractor generally tends to incur the costs of his work performed for the job, while an employee does not.

The type of employer-worker relationship. An employer-employee relationship generally comes with far more formal requirements and benefits. This might include an employee contract, health insurance, and unemployment benefits. An independent contractor relationship, on the other hand, typically does not entail any of these, and can even exist merely with an oral agreement.

The misclassification of workers as independent contractors is a recurring issue for many business owners. If you have questions about whether your workers are technically employees or contractors, it may be wise to consult an experienced employment lawyer near you.